Investors, besieged with financial news, reports, and information daily, may be inclined to constantly tinker or make adjustments to their portfolio. By following the advice from a recent article or a talking head, they can be susceptible to the latest fad or market predictions and may get caught up in the excitement of chasing what are all too often allusive returns. In his piece “The Art of Letting Go,” Dimensional Fund Vice President, Jim Parker suggests that investors might be better served by following the Chinese Taoism tenant of “wuwei,” or, “non-doing” than micro managing their portfolio. Find this month's article below.
May 29, 2013
The Art of Letting Go
Jim Parker
Outside the Flags
Vice President , Dimensional Funds
In many areas of life, intense activity and
constant monitoring of results represent the path to success. In investment,
that approach gets turned on its head.
The Chinese philosophy of Taoism has a word
for it: “wuwei.” It literally means “non-doing.” In other words, the busier we
are with our long-term investments and the more we tinker, the less likely we
are to get good results.
That doesn’t mean, by the way, that we
should do nothing whatsoever. But it does mean that the culture of “busyness”
and chasing returns promoted by much of the financial services industry and
media can work against our interests.
Investment is one area where constant
activity and a sense of control are not well correlated. Look at the person who
is forever monitoring his portfolio, who fitfully watches business TV, or who
sits up at night looking for stock tips on social media.
In Taoism, by contrast, the student is
taught to let go of factors over which he has no control and instead go with
the flow. When you plant a tree, you choose a sunny spot with good soil and
water. Apart from regular pruning, you leave the tree to grow.
But it’s not just Chinese philosophy that
cautions us against busyness. Financial science and experience show that our
investment efforts are best directed toward areas where we can make a
difference and away from things we can’t control.
So we can’t control movements in the
market. We can’t control news. We have no say over the headlines that threaten
to distract us.
But each of us can control how much risk we
take. We can diversify those risks across different assets, companies, sectors,
and countries. We do have a say in the fees we pay. We can influence
transaction costs. And we can exercise discipline when our emotional impulses
threaten to blow us off-course.
These principles are so hard for people to
absorb because the perception of investment promoted through financial media is
geared around the short-term, the recent past, the ephemeral, the narrowly
focused and the quick fix.
We are told that if we put in more effort
on the external factors, that if we pay closer attention to the day-to-day
noise, we will get better results.
What’s more, we are programmed to focus on
idiosyncratic risks—like glamor stocks—instead of systematic risks, such as the
degree to which our portfolios are tilted toward the broad dimensions of risk
and return.
Ultimately, we are pushed toward fads that
the financial marketing industry decides are sellable, which require us to
constantly tinker with our portfolios.
You see, much of the media and financial
services industry wants us to be busy about the wrong things. The emphasis is
often on the excitement induced by constant activity and chasing past returns,
rather than on the desired end result.
The consequence of all this busyness, lack
of diversification, poor timing decisions, and narrow focus is that most
individual investors earn poor long-term returns. In fact, they tend to not
even earn the returns available to them from a simple index.
This is borne out each year in the analysis
of investor behavior by research group Dalbar. In 20 years, up to 2012, for
instance, Dalbar found the average US mutual fund investor underperformed the
S&P 500 by nearly 4 percentage points a year.
This documented difference between simple
index returns and what investors receive is often due to individual behavior—in
being insufficiently diversified, in chasing returns, in making bad timing
decisions, and in trying to “beat” the market.
Recently, one of Australia’s most
frequently quoted brokers broke ranks from the industry and gave the game away
on this “busy” investing. In his final note to clients before retiring to
consultancy work, Morgan Stanley strategist Gerard Minack said he had found
over the years that investors were often their worst enemies.
“The biggest problem appears to be
that—despite all the disclaimers—retail flows assume that past performance is a
good guide to future outcomes,” Minack said.
“Consequently, money tends to flow to
investments that have done well, rather than investments that will do well. The
net result is that the actual returns to investors fall well short not just of
benchmark returns, but the returns generated by professional investors. And
that keeps people like me employed.”
It’s a frank admission and one that
reinforces the ancient Chinese wisdom: “By letting it go, it all gets done. The
world is won by those who let it go. But when you try and try, the world is
beyond the winning.”
